Price to Sales Multiple Question framework, advantage, reference, following, management

Spongebob

This is an question from the kaplan Qbank with reference Id 96399

Which of the following is least likely an advantage of using price/sales (P/S) multiple?


A) P/S multiples are more reliable because sales data cannot be distorted by management.

B) P/S multiples provide a meaningful framework for evaluating distressed firms.

C) P/S multiples are not as volatile as P/E multiples and hence may be more reliable in valuation analysis.


Please. Explain your answer.
Thanks in advance.

manasib

Answer is A) P/S multiples are more reliable because sales data cannot be distorted by management.

Sales can absolutely be distorted by management, thats why we look at factors such as receivables turnover, quality of earnings ratio, to make sure that management is not prematurely recording revenue and so forth.


B) is correct, since distressed firms experience negative earnings, making P/E valuation meaningless, sales on the other hand cannot be negative, neither can stock price.

C) P/S multiples are not as volatile as P/E for the reason that sales is the first line-item on the Income Statement, Earnings is the last, hence everything in between can be distorted in order to affect bottom line, top line is more difficult to distort, but its still possible.

Hope that helps.

ishfaque

It's a straightforward A.

JGovender

It is a horrible question, but I would say A simply because they use the word "cannot" be manipulated by management versus softer language such as "not as easy to manipulate" etc.
Revenue recongnition policies, which is a management decision, can be used to manipulate the top line.

Flok

yea there's a whole section on revenue recognition and channel stuffing etc